OVX Alert: Crude Oil Volatility Picks Up Steam

Just as we predicted in a previous blog post, volatility in crude oil has been rising as an important meeting involving some of the world's biggest producers inches closer on the calendar.

On May 25th, a group including both OPEC and non-OPEC representatives will meet to decide whether the current worldwide production cut will be extended.

After agreeing to cut approximately 1.8 million barrels/day of production starting on January 1st of this year, the group now needs to decide whether to increase the cuts, extend the cuts, or scrap the deal altogether.

While that meeting is still a couple weeks off, crude oil prices tumbled during the first week of May with WTI dropping below $45/barrel for the first time since November of 2016 - which was when prices rallied furiously after the original deal was successfully negotiated.

The tumble in WTI prices from around $49 to below $45 in early May is likely enough on its own to convince most traders that volatility has picked up in crude oil and securities tied to it. However, this is easily confirmed by a glance at the CBOE Crude Oil Volatility Index (OVX), which just notched its highest levels of the year (close to 35).

The OVX got decimated after the original OPEC deal and dropped from above 50 to below 30 in just a few weeks. Now, after trading in a fairly tight range since last December, the OVX spiked around 20% from May 2nd to 5th.

What's intriguing about the most recent pop in OVX is that most market participants at this time probably expect the OPEC deal to be extended. Instead, traders appear to be rattled by the somewhat limited success of the current deal.

After four full months of cuts, worldwide crude inventories remain stubbornly high. The fact that production from the United States has been opportunistically rising (when oil prices rallied above $50), hasn't helped either.

The international rig count, which measures the number of offshore platforms drilling for "black gold," has nearly doubled from April 2016 to April 2017. A clear indication that production, even outside the US, has been steadily coming back online.

Adding even more mystique to the current developments in the oil patch, is the VIX, which actually declined while the OVX was staging its big rally. If that trend were to continue, traders may consider looking more closely at opportunities in both of these products.

For the time being, all eyes are still are the weekly crude oil inventory reports, which provide valuable insight into the ongoing crude oil supply-demand dynamic. If OPEC does ultimately agree to extend (or even deepen) the cuts, the weekly inventory reports should provide the first glimpse into a possible paradigm shift (from overproduction to underproduction).

Obviously, for traders of oil and related securities/products, May 25th also looms very large.

If you have any questions about the OVX, or trading commodities in general, we hope you'll reach out support@tastytrade.com.

We look forward to hearing from you!

Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.

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